Look beyond China when investing in Asia

It is rare to talk about investing in Asia without focusing on China. Given China’s heft and dominance in the region, how it fares economically affects not just Asia but the world. Yet for better or worse, with this year’s intense market volatility and velocity, more investors are willing to look beyond China and consider opportunities elsewhere in Asia—and there are plenty.

The slowdown in developed economies has been a significant drag on Asia’s economic growth since last year, but we are seeing a nascent recovery. ASEAN (The Association of Southeast Asian Nations) countries are bouncing back on pent-up consumer demand and low inflation. Rising commodity and energy prices are also giving net commodity exporters like Indonesia and Malaysia an extra revenue boost compared to other Asian countries. Reforms on education and labor laws as well as efforts to transform the nickel industry should put Indonesia in a good position to benefit from supply chain diversification. Its large domestic economy also serves as a buffer should global demand continues to be weak.

Middle classes and asset classes

From a structural angle, the middle class in Asia is growing and this supports rising demand for goods and services. A growing middle class with rising income is willing to pay a premium for better quality products and services, which boosts the overall consumption. Also, emerging leaders in semiconductors, hardware and e-commerce are making technological advances that present opportunities.

Following the correction of 2021, the valuations of Asian risk assets have reached attractive levels. In general, equity multiples are at levels not seen since early 2016, and non-investment grade z-spreads-to-worst are at historic highs.

High dividend stocks in select Asian Pacific markets offer income as well as defensiveness as they tend to perform relatively well under different economic cycles. Corporate bonds in Asia also offer an attractive risk/return profile compared with that of the US. Asian REITs provide stable income and an inflation hedge in an environment of rising rates and higher inflation.

Alpha opportunities in the region are growing. The inefficiencies of Asian capital markets still offer gaps that can be exploited—but only for a time as these markets continue to attract analyst coverage, flow and turnover.

Spotlight on Asian REITs

The rising interest rate environment has taken its toll on the performance of REIT shares, and acquisitions deals have been challenged by higher hurdles from rising borrowing costs.

But we still think the Asian real estate market is in a relatively good position to handle the volatility in the medium term. Leasing momentum is expected to remain resilient as economies recover from the pandemic. However, should inflation stay elevated and central banks’ tightening continue to outpace growth, the post-pandemic recovery could weaken demand for real estate assets. Japan and Singapore are likely to attract capital with their favorable cost of finance and positive cash on cash yield across all asset classes.

Within REITs, industrial properties fared the worst so far this year, after being big winners during the pandemic. Logistics leasing and rental growth are expected to weaken in the coming quarters as economic activity slows and global supply chain operations normalize. The retail sector was affected by global economic headwinds during the pandemic. We believe the regional retail market will recover slowly as rising inflation and growing economic uncertainty weigh on consumption. Retailers are also likely to remain cautious and take longer to commit to major expansions amid rising operating costs.

Momentum swung toward offices as workers began returning to their offices, but recovery will vary per market. Singapore and Seoul office space is relatively tighter than in the regional markets, and we should see rental growth support in the core central areas.

Due to geopolitical uncertainties, investors continue to seek safer havens such as Singapore, Australia and Japan. REITs in these markets are likely to benefit from such trends, with capital inflows boosting real estate valuations. Singapore REITs are viewed as safer than global REITs, but relative valuations have become more expensive. Australia REITs are now more attractive given the recent correction. Japanese retail and hospitality REITs are likely to be supported by the reopening of the border.

Asia equals diversification

There are plenty of investment opportunities in Asia to be considered when looking for diversification. Varied asset classes in countries from India to Korea can behave differently under changing business cycles and regimes, and a multi-asset approach can be a way to achieve better risk-adjusted return.